MauledAgain

Prof. James Edward Maule's more than occasional commentary on tax law, legal education, the First Amendment, religion, and law generally, with sporadic attempts to connect all of this to genealogy, theology, music, model trains, and chocolate chip cookies. Copyright 2004-2019 James Edward Maule.

Friday, September 29, 2017

Age Is Not “Just a Number,” But Sometimes It Is the Wrong Number

About a month ago, in For Tax Purposes, Age Is Not “Just a Number”, I described the outcome in a case involving a taxpayer’s failure to prove that he was at least 59 and a half years of age when he withdrew money from his IRA. My introduction to that discussion included examples of age determination challenges encountered while doing genealogy and family history research. One example involved people making themselves a year younger on World War One draft registration forms. Another example involved people making themselves a year older on social security retirement benefits applications. Still another example involved people born in Europe who used the European rather than the American birthday counting convention.

About a week ago, a reader shared with me another example of how age determination challenges can arise. The story involves a now-deceased older relative of the reader. This relative was born early in January. The person at the hospital filling out the birth certificate made the same sort of error many people do when writing checks early in a new year. That person wrote the year that had closed. So instead of showing, for example, the birth as January 3, 2017, it was recorded as January 3, 2016. The reader’s relative knew that the certificate was wrong, but always used the correct birth date. When the relative retired from a teaching position and applied for social security benefits at the age of 65, both the state teacher’s pension system and the Social Security Administration insisted that the reader’s relative was 66, and computed benefits using the age of 66. According to the reader, his relative’s “protestations were ignored.”

Had the reader’s relative not have a sense of integrity, the relative could have obtained a driver’s license at age 15, and could have made alcohol purchases at age 20. Surely those things did not happen, not by a person with the integrity to protest use of the wrong age. I wonder if any other person born in January, especially early in January, has had the birth recorded with the wrong year for this same reason. And I wonder how many went through life as a year older than their true age. And I wonder if it worked to anyone’s disadvantage, such as being called up for the military draft a year sooner than ought to have happened.

Wednesday, September 27, 2017

The Tax Fake That Will Not Die

Supply-side economics is a fake. Trickle-down economic theory demonstrates its untruth when it meets practical reality. Tax cuts for the wealthy do little, if anything, for those who are not wealthy. I have explained my disbelief in this nonsense in posts such as Job Creation and Tax Reductions and Do Tax Cuts for the Wealthy Create Jobs?. By now, with the evidence from states such as Kansas, where tax cuts for the wealthy generated fiscal disaster, and Minnesota, where tax increases on high incomes ignited the state’s economy, reasonable people might expect that the supply-side, trickle-down advocates would call it a day. But, no, that hasn’t happened.

Michel begins by asserting that “wages rise when the demand for workers increases.” This is true. The challenge is to identify what causes increases in demand for workers. Michel denies that corporate tax cuts don’t simply increase profits for owners, shareholders, and top hat employees. Instead, he attempts to prove that if corporations receive tax cuts, they will increase worker salaries, hire more workers, or both.

Michel begins by claiming that this nation’s corporate income tax rate is one of the highest in the world. What Michel ignores is that statutory tax rate are relevant only when a profitable corporation has positive taxable income. The statutory tax rate is meaningless to corporations that offset economic profits with tax shelter and other losses. Michel also ignores the effect of tax credits, which can reduce and eliminate tax liability based on statutory tax rates. If a corporation has sufficient artificial and other losses, or credits, or both, a 100 percent statutory rate has no practical adverse effect.

Michel also claims that high tax rates discourage investment in workers. He claims that business investment in machinery and technology make employees more productive. A good chunk of business investment in machinery and technology causes job loss, as machines and robots replace human workers. That’s job dissolution, not job creation.

Michel then asserts that because businesses invest in machinery and technology, employees become more productive, causing profits to increase, and thus permitting businesses to hire more workers. That’s utter nonsense. When installation of machinery and robots cause higher productivity, it can, but does not necessarily, increase profits, but it leads to more purchases of machinery and robots, not the hiring of more workers. Worse, no matter how productive a business is, profits will not increase, and will decrease, if demand fails to increase or, as often happens, decreases. Demand decreases when people lose jobs and when people’s real income declines.

Michel then proclaims that increasing business investment would increase wages by at least 13 percent, and perhaps as high as 20 percent or more. Anyone who believes that sales pitch might be in the market for any version of the “give me more money and you’ll get richer” ploys that can be found whichever way one turns.

When taxes are cut for businesses and high-income individuals, they do not give existing employees pay raises. How do we know that? Because despite a parade of tax cuts for the wealthy and businesses since 1981, real incomes for Americans, other than the sheltered top tier, have remained stagnant. Nor do they run out and hire people. They don’t do that because they have no need for employees. What will the new employee do if the existing employees are handling existing demand? If demand increases, businesses will hire new employees, despite tax rates, because increased demand will increase profits. Granted, businesses prefer the highest possible after-tax return, but a positive after-tax return of any amount is better than the zero profit increase that takes place if a business facing increased demand decides to ignore it and not hire workers to help meet it.

Michel misses another point. Compensation is deductible, and some forms of compensation generate tax credits. The mere act of hiring a worker reduces the taxable income and the tax liability of a business. It’s that simple.

Michel is correct that anemic economic growth is afflicting the nation. What he ignores is the link between income and wealth inequality on the one hand, and stagnation in demand on the other. Smart business owners understand, as did Henry Ford, that if their workers cannot afford to sell the products offered by the business, the business won’t be around for very long.

What will create jobs is an increase in demand, 90 percent of which comes from the 99 percent who are not in the economic top one percent, and the best way to stimulate demand among the 99 percent is to [give them] tax cuts. Ironically, where work needs to be done, such as highway and bridge repair and maintenance, refurbishment of public infrastructure such as storm sewer systems, firehouses, schools, sanitary sewage systems and plants, dams, national cybersecurity, and similar public improvements, the advocates of tax cuts for the wealthy hold a position that guarantees the lack of funding for most, if not all, of what needs to be done to keep the nation vibrant in a changing world economy.

It should be obvious what this debate is all about. It’s about greed. Hiding the role of greed as the motivating factor for misrepresentations and half-truths becomes difficult when people can see the true agenda. If the wealthy[, corporations, and businesses] wanted to create jobs, they could be creating jobs as I write while getting tax benefits in the form of deductions and even, in some instances, credits. Instead, they hold the nation hostage while claiming, falsely, that jobs will be created only if [there are tax cuts for corporations, businesses, and the wealthy].

Time and again, we’ve been down the road Michel suggests, and time and again the economy gets lost, becomes stuck, and crashes. That road doesn’t get us there. It’s time to take another road.

Monday, September 25, 2017

Internal Revenue Code Sections and Subsections

The title of the post, IRS Revenue Code Section 280: A Tax Potpourri, was yet another example of the idiocy of referring to the Internal Revenue Code as the IRS Revenue Code. Think about it. Is there Really an Internal Revenue Service Revenue Code? Please. This is not the first time I have tried to help people understand the difference between the IRS and the Internal Revenue Code. That difference matters, as I have explained in posts such as Is Tax Ignorance Contagious?, Code-Size Ignorance Knows No Boundaries, and Intentional Misleading Tax References.

But it quickly became far worse than nomenclature sloppiness. The blog post in question was a complaint that “the government decided to dump into one place,” namely, the now correctly designated “Internal Revenue Code section 280,” what the writer called “a conglomeration, a potpourri, and a mass of all kinds of stuff.” Curious, I continued to read. The writer explained, “We’re dealing with a lot of subsections in 280. I’m going to be going through A, B, C, D, E, F, G, and H.” Immediately, I realized that the writer did not understand how the Internal Revenue Code was structured. The writer does not understand the difference between a Code section and a Code subsection, nor does the writer understand how Code sections are numbered.

The numbering system of the Internal Revenue Code follows a pattern. This pattern was adopted when the Internal Revenue Code of 1954 was enacted, replacing the Internal Revenue Code of 1939. The pattern in the Internal Revenue Code of 1954 was followed when the Internal Revenue Code of 1986, the current version, was enacted. Essentially, the drafters identified the topics addressed by the Code. They grouped these topics and then grouped the groupings. Because the Internal Revenue Code is title 26 of the United States Code, the highest level of groupings were designated subtitles. Subtitle A deals with income taxes, subtitle B deals with estate and gift taxes, subtitle C deals with employment taxes, and so on. In turn, subtitles are divided into chapters. For example, chapter 1 of subtitle A deals with normal taxes and surtaxes, whereas chapter 2 deals with tax on self-employment income, and so on. Chapters are divided into subchapters. For example, subchapter A of chapter 1 of subtitle A deals with determination of tax liability, subchapter B deals with computation of taxable income, and the somewhat well-known subchapter S deals with what everyone knows as “subchapter S corporations,” or simply, “S corporations.” In turn, subchapters are divided into parts, and some, but not all, parts are divided into subparts.

The assignment of numbers to Code sections was designed to “leave room” for future legislation. Thus, for example, part I of subchapter A of chapter 1 of subtitle A starts with section 1. It ends with section 5. Part II of that subchapter starts with section 11. There is no section 6, nor 7, 8, 9, or 10. Turning to subchapter B of chapter 1 of subtitle A, which deals with the computation of taxable income, part I, dealing with the definition of gross income, adjusted gross income, taxable income, etc., begins with section 61 and ends with section 68, part II, items specifically included in gross income, begins with section 71. Part IX of subchapter A of chapter 1 of subtitle A deals with “Items Not Deductible.” It begins with section 261. Part X, which deals with Terminal Railroad Corporations and Their Shareholders, starts at section 281. Presumably, when this assignment was made, the drafters of the 1954 Code figured that leaving sections 261 through 280 for nondeductible items would be sufficient. They were wrong.

By 1976, Congress reached section 280, which limited deductions for expenditures attributable to the production of films, sound recordings, books and similar properties. In the same year, Congress wanted to add limitations on deductions attributable to personal residences, specifically, home offices, in-home child care facilities, and vacation homes. It could not use section 281, because that was already in use, and renumbering Code sections and moving them around was considered to be even more confusing. So Congress resorted to a technique it had used on previous occasions when it had “run out of numbers,” and concluded that the next number would be section 280A. Not subsection 280A, but section 280A. It did NOT insert the personal residence deduction limitations into section 280. In 1976, Congress also enacted limitations on deductions attributable to the demolition of structures, and put those into section 280B. Over the years, Congress continued to add deduction limitations, in response to maneuvers in which taxpayers engaged, and eventually added section 280C, section 280D, section 280E, section 280F, section 280G, and section 280H. These are each separate sections. They are not part of section 280. The language in each of these sections is not part of section 280, and thus cannot be considered to have been “dumped into section 280.”

Most of these sections have subsections. Thus, for example, section 280A has subsections (a) through (g). Notice that subsections are designated by lower-case western alphabet letters in parentheses. In contrast, when letters are part of section numbers, they are in upper-case and there is no intervening parenthesis or other punctuation. Granted, it is strange that Code numbers contain letters, but that is a quirk with which tax professionals need to be familiar. A similar set of constructs deal with the lettering and numbering of paragraphs, subparagraphs, clauses, subclauses, and more, which I explained in, for example, Internal Revenue Code: Small Change, New Feature, New Look.

Thus, to call section 280A a subsection would generate absurd challenges and ridiculous outcomes when trying to describe 280A(a). Would it be “subsection 280A subsection a”? Would it be “subsection a of subsection 280A”? Please.

When I teach the basic federal income tax course, I give the students materials to assist them in understanding how the Internal Revenue Code is structured and how its elements are arranged and designated. I do the same with Treasury Regulations, which have their own arrangement and terminology. I do this because understanding cross-references, citations in judicial opinions, and tax law analysis requires an appreciation of how the Code and the regulations are arranged and designated. It’s a foundation element of tax law practice.

Thus, it is distressing to read “They just buried all kinds of things in there [section 280].” Aside from the fact that the “things” that are described are NOT in section 280, it is disappointing that the writer did not comprehend that what sections 280A through 280H address are non-deductible expenditures, not ‘all kinds of things.” It is also distressing to read “So, in section 280, we’ve got automobiles.” No, we do NOT. There is nothing in section 280 about automobiles. Limitations on deduction of automobile expenditures is in section 280F. Then, when reading, “There are probably 15 different code sections here, but they dumped them all into one,” I realized that the writer of the commentary surely did not understand much, if anything, about the Internal Revenue Code. So who is this writer? I don’t know the person’s name. It’s not mentioned. The writer describes himself or herself as “an expert in the Internal Revenue Manual,” as someone who “worked there [the IRS] for 30 years,” and who has “been teaching for another 20 years.” My guess is that the writer is not a lawyer, has not studied tax from the “Code first” approach that tax lawyers and most other tax professionals use, and uses the “begin with the Internal Revenue Manual or someone’s paraphrased analysis” approach that some of my students – specifically, some of the undergraduate accounting majors – unsuccessfully insist that I use in my courses.

In all fairness, most of the writer’s commentary is a description of tax rules and cases dealing with issues to which sections 280A through 280H are applicable. Though presented in a somewhat stream-of-consciousness pattern, there is useful information in the commentary. It is unfortunate that those reading the commentary, and those attending the presentations of which the commentary appears to be a transcript, are totally misled with respect to how the Internal Revenue Code is arranged, and are left with the impression that the material in sections 280A through 280H are part of section 280. It is unfortunate that they are left with the impression that there is no coherent and logical structure behind the arrangement and designation of Code sections and that sections 280A through 280H are not a dumping ground but a series of deduction limitation provisions. It is unfortunate that they are left with the wrong impression of what sections and subsections are.

Sometimes I think that trying to stem the storm surge of ignorance is as futile as holding one’s finger in a dike while the waves crash over it. But I will continue my efforts to educate the world. At the very least, it’s therapeutic. Perhaps somewhere, someone will read something I write and think, “Aha.” That is the blessing of teaching that generates a beneficial result.

The most recent Judge Judy that I viewed, but for which I cannot find a link, was difficult to follow, because the parties disagreed with respect to the facts, and at certain points provided different answers to the a question when it was repeated. The plaintiff’s daughter-in-law had formerly been married to the defendant. The daughter-in-law and the defendant had two children before their relationship ended. The daughter-in-law and the plaintiff’s son married, and had one child.

Until some point in 2016, or perhaps 2015, the defendant’s two children lived with him. At first he claimed that he had custody and they lived with him until June of 2016, but then he admitted that his two children lived with their mother, the plaintiff’s daughter-in-law. He then stated that he had custody in 2014 and 2015, but the plaintiff agreed only that the defendant had custody during 2014 and the first half of 2015.

At some point, the defendant became homeless and surrendered custody of his two children to their mother. He also commented that he and the children lived with his aunt, but it was unclear for how long, because the parties also cross-talked in arguing that point.

So at some point in 2016, or perhaps in 2015, the plaintiff’s daughter-in-law and her husband, the plaintiff’s son, ended up with custody of all three of the daughter-in-law’s children. The daughter-in-law and her husband somehow became caught up in illegal drugs, and Child Protective Services threatened to take all three children. At that point, in the fall of 2016, the plaintiff took custody of all three children. However, the oldest child of the defendant had issues, so eventually that child ended up in a group therapeutic foster home. The defendant asserted that he visited the other child several times while that child was in the plaintiff’s custody.

When filing his income tax return for 2016, the defendant claimed dependence exemption deductions for his two children. When asked, he explained that he had also claimed two exemptions for the children in 2014 and previous years. The plaintiff sued the defendant because she wanted to claim the children as dependents.

Judge Judy remarked that the parties needed to take the custody issue back to family court. She concluded that the two children had spent most of their lives with their father. She dismissed the plaintiff’s claim.

Judge Judy did not decide, nor did she need to decide, who was entitled to dependency exemption deductions for the two children. Answering that question, even if it was within the scope of the case, would require additional facts. Because the children were step-children of the plaintiff’s son, and thus step-grandchildren, the only relationship test that they possibly could meet is that of someone residing in the plaintiff’s home for the entire year. Even if that had been so, and it wasn’t, there were other requirements that would have been met. Whether the defendant or the children’s mother was entitled to the exemption is a different question, and it did not need to be resolved in order to conclude that the plaintiff had no claim.

This case provides an excellent example of one of the several reasons tax law is complicated. It is simple to state that a person is entitled to claim a dependency exemption deduction for a child, but that simple rule is impossible to apply when the facts become complicated. Who is a child? What about step-children? Adopted children? Foster children? Children of separated or divorced parents? Children who are shuttled from home to home? Children who are in and out of the foster care system? Children in the custody of the state? Each one of these situations requires a rule. Suddenly the simple, conceptual rule is joined by a parade of additional rules. The applicable law becomes complicated. Worse, each of the terms used in the additional rules requires definitions and imposes conditions.

Though it’s true that a good chunk of tax law complexity arises from provisions enacted to benefit the privileged few, or to satisfy special interests, another chunk of tax law is complicated because life is complicated. People live complicated lives and engage in complicated transactions. Business owners, business entities, trusts, and estates also engage in complicated transactions. And so long as that is how life progresses, it is highly unlikely that tax laws will become simple.

Wednesday, September 20, 2017

Reverse Tax Logic

According to this report, the chair of the Presidential Advisory Commission on Election Integrity suggested that “when burdens like poll taxes and literacy tests were imposed on citizens and registering often required a trip to the local courthouse, voter turnout was far higher than it is now.” Surely any correlation is a coincidence and not a matter of causation.

Using this logic, doubling the price of a product should increase sales. Charging admission for events that had been free should boost attendance. This is the same sort of reverse tax logic that claims lowering tax rates to near zero will generate huge increases in tax revenue.

I’m being nice using the word reverse. A much better phrase to use is twisted tax logic.

Monday, September 18, 2017

Is Anti-Tax Sentiment Weakening?

For almost two decades, Americans have been told, time and again, that they oppose tax and fee increases. Enormous sums of money have been plowed into efforts to persuade Americans that taxes are a bad thing and to persuade legislators to refrain from enacting or increasing taxes and to reduce or repeal those that exist. Some people have made careers out of, and have profited from, anti-tax campaigning.

According to a new survey from HNTB Corporation, 70 percent of Americans are willing to pay higher taxes and tolls to build, repair, and maintain roads, tunnels, and bridges. Some prefer higher taxes, some prefer tolls and fees, and some prefer a combination. If those taxes and tolls were guaranteed to be used only for transportation projects, the approval percentage increases from 70 to 84. According to the survey, 80 percent support tolls on existing highways, including interstate highways, if the revenue was used for specific purpose. Of those polled, 41 percent support tolls to reduce congestion, 40 percent support tolls to improve safety, 34 percent support tolls to add capacity, and 21 percent support tolls to add or improve adjacent public transportation to relieve congestion. The other 20 percent are opposed to tolls under all circumstances. Apparently they were not asked how they would fund highway repairs.

So how is it that we are told that Americans, or at least a majority of them, oppose taxes, fees, and tolls, and yet surveys – the HTNB poll being but one – indicate that most Americans support taxes, fees, and tolls for transportation infrastructure? Have Americans changed their minds? Or has there been a misrepresentation of American opinion, making the desires of an elite few appear to be the clamor of the general populace? Perhaps it is a mixture of both.

It is not unlikely that Americans, having seen the real-world impact of the theoretical tax-cuts-for-the-few-benefit-the-many nonsense, are beginning to understand the connection between government revenue and life convenience. For several decades, resistance to increases in fees and taxes, such as the liquid fuels tax, has gifted Americans with more potholes and the attendant costs, both human and monetary, of inadequate funding. How many Americans realize that during the past four years, 26 states have increased liquid fuels taxes?

The key, I think, is making certain that Americans receive services in exchange for the taxes that they pay. There appear to be people who think that they should go through life enjoying public benefits, such as roads, without paying taxes. Though some might take that position through selfishness, there surely are those whose attitude arises from ignorance. It is essential that public officials explain to constituents where their tax, fee, and toll dollars go. Eventually, the anti-tax crowd, aside from the anti-government anarchists, will realize that Americans do not oppose taxes or even tax increases, but oppose irrational taxes, inexcusable tax systems, and oligarchic tax policies.

Friday, September 15, 2017

A Tax Challenge: Simplicity Versus Fairness

Taxpayers complain about the complexity of tax laws and tax forms, to say nothing of the inconvenience of keeping records and digging up information in order to comply with tax laws. But taxpayers also complain when they perceive tax laws to be unfair, and those complaints are a seemingly never-ending stream. But is there not a conflict between simplicity and fairness?

The Vermont Tax Department, according to this story, is trying to boost voluntary compliance. It is inviting Vermont residents to pay past due use taxes, with an incentive in the form of interest and penalty waivers. Vermont offers two methods of computing the tax. One is to maintain a list of all purchases subject to the use tax, to add up the prices, and to multiply by the tax rate. The other is to pay an amount based on the taxpayer’s adjusted gross income.

The choice presented to Vermont taxpayers illustrates the tension between complexity and fairness. Keeping track of all out-of-state and online purchases is inconvenient, perhaps annoying, and usually difficult. At the time of each purchase, or thereafter, the taxpayer must determine if the item is subject to, or exempt from, the use tax, and must also determine whether the item was brought back to, or shipped into, Vermont. Calculating a tax based on adjusted gross income is much simpler, but it generates unfair results because two people with the same adjusted gross income ought not pay the same use tax if one has made many taxable purchases and the other has made far fewer taxable purchases. The latter situation arises if the person saves a substantial portion of income, or makes large payments for nontaxable expenses, such as tuition.

The choice presented to Vermont taxpayers is not unlike the choice given to taxpayers who are, or were, eligible to deduct state and local sales and use taxes on their federal income tax returns. Taxpayers can keep track of what they paid, or use a table based on income, state of residence, and number of exemptions. The table is very popular, but in this instance the perception of unfairness is dampened by the fact it is generating a tax benefit and not a tax liability even though economically one can demonstrate differences in tax liability when using the table in comparison to using itemized receipts.

It has been known for as long as taxation has existed that every attempt to make a tax fairer requires adding complexity. Every exception, exemption, reduction, alternative, or adjustment requires additional language and lines on tax forms. Every one of those tweaks opens up additional possibilities for disagreement and generates additional hours of research, preparation, compliance, disagreement, and litigation. Even though many people clamor for a simple tax system, there is no doubt that implementation of a simple system, or even a simpler system than now exists, will generate as many, or more, cries for fairness that erodes the simplicity. This is a tax fact of which no taxpayer should be ignorant.

When something new is proposed, it is not uncommon for many people, even if they are not natural skeptics, to hesitate and to doubt. A fine way to overcome doubts before committing to a permanent change is to sample the idea, to test the concept, to try a temporary test, or to engage in a pilot program. That is what states have been doing with the mileage-based road fee proposal. According to the Mileage-Based User Fee Alliance, at least 9 states, one city, and one multistate interstate group have engaged in, or are engaging in, pilot projects. Now comes news that Utah is preparing to set up a pilot project.

As more states, and localities, experiment with mileage-based road fees, and as the pilot projects continue to return mostly positive outcomes, general acceptance of the idea will grow. Better yet, as the pilot projects are undertaken, snags in the implementation can be identified and worked out, improvements can be made, and more can be learned about the best way to explain how mileage-based road fees work. Like the often-mentioned snowball rolling down the hill, this trend suggests that mileage-based road fees have a better chance of being universally adopted long before self-driving vehicles totally displace vehicles with human drivers.

Readers also know that I haven’t had the time or opportunity to watch all of them. So when they come upon a show they think I haven’t seen, because there’s no commentary on this blog about the show, they send me a link. Not long ago, a reader directed me to this Judge Judy episode. For many people, tax professionals and others alike, it provides insight into how a particular tax scam works.

The plaintiff and the defendant had been a couple, but were not married. The defendant had a child from an earlier relationship. The plaintiff explained that he had been led to believe he was the father of a child whose mother was a woman who lived in the Bronx. When it came time for the plaintiff to file his 2009 federal income tax return, the defendant, knowing that the child’s mother needed help and wanting to help her, mentioned this to the defendant. The defendant, or her sister, a tax return preparer, allegedly told the plaintiff that the best way to help the mother was to claim the child as a dependent and apparently to give her the tax refund generated by the dependency exemption deduction and child tax credits. According to the plaintiff, the defendant’s sister prepared the return, and asked him how he wanted to receive the refund. Because he had no bank account, he told her to have it mailed to him. Then, according to the plaintiff, the defendant’s sister called and told him the refund would arrive more quickly if it were sent to a bank account, so she persuaded him to let it be deposited in the defendant’s bank account, and then the defendant would give the money to the plaintiff. The refund went into the account, but the defendant did not pay it to the plaintiff. The plaintiff sued. The defendant justified keeping the money because of the plaintiff’s bad temper and some things he had allegedly damaged. The defendant claimed that the plaintiff had agreed she could keep the money, but the judge did not believe her.

Judge Judy began by interrogating the plaintiff. He explained that he claimed two exemptions on the return, himself and the child. The child lived with the child’s mother. In response to whether he supported the child, the plaintiff stated that he watched him, took care of him, and gave him some things that the child needed. The plaintiff did not live with the child or the child’s mother. There was no child support order in place, and the child’s support came from welfare payments. Judge Judy then asked, “So your son is on welfare and you claim him as a dependent?” The plaintiff explained that the child’s mother had told him it was his child, but then in March of 2010 he discovered it was not his child.

Judge Judy explained to the plaintiff that by claiming the child as a dependent, the size of the refund was enlarged. But because the child is not a dependent, the plaintiff is not entitled to the portion of the refund attributable to claiming the child, the IRS wants the money back. So the judge said to the plaintiff, if the defendant were ordered to pay the money to you, I assume you will return it to the IRS. She then pointed out, “We can do that for you.”

Judge Judy asked the plaintiff the age of the child. The plaintiff said, “Four.” The judge asked if he had claimed the child as a dependent on tax returns for earlier years. The plaintiff replied, “No.” The judge asked, if you thought the child was yours, why did you not claim the child in the earlier years? The plaintiff did not provide an explanation. Asked who prepared his tax returns in earlier years, he replied, “H&R Block.”

The judge then asked the plaintiff, “So why did you claim child in 2010?” That is, why did you claim him on your 2009 income tax return when it was being prepared in 2010? The plaintiff said that the defendant’s sister, the tax return preparer suggested it. But then plaintiff said that it was the child’s mother who said he could claim the child.

Judge Judy asked to see the return. It was filed in March 2010. On further inquiry, the plaintiff claimed that it was after the return was filed that he discovered that the child was not his.

Judge Judy told plaintiff that he needed to file an amended return, removing the child as a dependent. She dismissed the plaintiff’s case based on the doctrine of clean hands, because she did not think he had done things properly with respect to the return.

Turning to the defendant, the judge asked “What do you have to do with this man’s tax returns?” The defendant explained that the plaintiff did not claim the child in question as a dependent, but claimed the defendant’s grandchildren as dependents. When asked to explain the relationship, the defendant said that the children in question were the children of a woman she had raised. That woman is the mother of two children, one of whom was the child the plaintiff claimed. When asked, the defendant admitted she had not adopted the woman in question. Thus, concluded Judge Judy, the alleged grandchildren were not the defendant’s grandchildren.

Judge Judy, not surprisingly, concluded that the entire set of transactions constituted a scam. She concluded that the defendant was complicit in the scam. She announced her intention to notify the IRS that the defendant has the money fraudulently received from the IRS as a result of the scam.

That there was a scam was obvious from two perspectives. First, the facts did not fit. The plaintiff supposedly thought a child was his, yet did not claim the child until the child was four years of age. The identity of the child was in dispute. The depositing of the refund into the bank account of someone other than the taxpayer is a red flag. The child’s mother was not someone in need of a dependency exemption. Second, the demeanor of the parties, along with the changes in parts of the story as the trial developed, suggested that they had broken one of the rules of conspiratorial scamming, that is, agree on one story and stick with it.

It’s unclear who the parties wanted to be the ultimate recipient of the money. Either the defendant or the mother of the children, or both of them, thought they would receive or split the refund. Perhaps the plaintiff was going to get a cut of the refund, but because he received nothing, it is possible that he was indeed duped by the defendant and her sister. It’s possible that the child’s mother was unaware of the scam, and perhaps was not going to receive anything. As I listened to the defendant’s voice beginning to shake, I got the sense that she didn’t anticipate encountering a judge who would break through what the defendant thought was going to be some sort of contract dispute to unearth the tax fraud. I wonder if the plaintiff filed an amended return, though hopefully someone would explain how that would be even a better outcome in terms of dealing with the defendant than suing. I wonder how things turned out between the IRS and the defendant.

Now comes news that the state of Washington has enlisted 2,000 volunteers to participate in a pilot program, at least the seventh state to do so. The participants won’t be paying the fee, but simply measuring what they would be paying if the fee were real, and comparing it to what they pay in liquid fuel taxes. Washington is initiating the pilot program for the same reasons other states have done so or are considering doing so. Washington is watching road construction and repair costs growing by 2.6 to 3.1 percent a year due to inflation, while fuel tax revenue increases by 0.7 to 0.9 percent.

Even though the pilot program is voluntary and costs the participants nothing, while perhaps satisfying the curiosity of some or all of them, in this survey of Washington residents, 58 percent opposed the idea. Yet in California, which conducted a pilot program with 5,000 participants, post-program surveys revealed that 85 percent of the participants were satisfied with the program, and 73 percent concluded that the mileage-based road fee is more fair than a liquid fuels tax. What’s the lesson? Sometimes it makes sense to explore something, try something, study something, and examine something before reaching a conclusion. When it comes to the mileage-based road fee, many of the people who oppose it will discover that they like it.

Wednesday, September 06, 2017

The Tax Consequences of a Child’s Beauty Pageant Activities

When a child wins money in a beauty pageant, should the gross income be reported by the child or the child’s parents? When expenses are paid in connection with a child’s beauty pageant activities, should those expenses, if deductible, be deductible by the child or the child’s parents? Those questions might appear to be invented for a test or exam in a basic federal income tax course, but they arise from a recent case.

In Pedrgon v. Comr., T.C. Memo 2017-171, one the taxpayers’ children participated in various beauty pageants. In 2011, the taxpayers paid $21,732 for travel, outfits, and other costs, and in 2012 they paid $15,445 for these items. In 2011, the child won $1,325 and in 2012, $1,850. On the advice of their tax return preparer, the taxpayers included the winnings in gross income on their 2011 and 2012 federal income tax returns, and they deducted the expenses, reporting the income and expenses on Schedules C. The preparer based his advice on his understanding of the child labor laws of the state in which the taxpayers lived. The IRS disallowed the deductions, explaining that the income and deductions of the child must be reported by the child on the child’s own income tax return.

The Tax Court agreed with the IRS. Under section 73(a), amounts received in respect of the services of a child are treated as the child’s gross income and not the gross income of the parent. Before the predecessor of section 73 was enacted in 1944, income received in respect of the services of a child was reported by parents who held rights to those services under local law. Because local laws varied from state to state, Congress enacted what is now section 73 in order to create uniformity. Similarly, under section 73(b), all expenditures attributable to amounts included in the child’s gross income solely by reason of section 73(a) are treated as paid or incurred by the child, even if the parent makes the expenditure. Thus, the gross income from, and any deductions attributable to, the child’s beauty pageant activities ought not to have been reported on the taxpayers’ tax returns. Though the taxpayers perhaps considered this outcome to be ugly, the court got it right.

The good news for the taxpayers was the Court’s determination that they relied in good faith on their tax preparer. Thus, they escaped liability for the accuracy-related penalties that the IRS had asserted.

Even if section 73 did not exist, the taxpayers’ attempt to deduct expenses that were 8 and 15 times the income that was generated would raise section 183 questions. Did the child, or the taxpayers, engage in the beauty pageant activities with the intent to make a profit? Though it is a fact question, it would not be surprising to discover, had the issue been reached, that a court would conclude that it was not a for-profit activity.

Monday, September 04, 2017

Taxing What Doesn’t Exist

As I mentioned a bit more than a year ago, in Taxation of Androids and Robots, and Similar Pressing Issues, I often use “tax consequences of time travel” as an example to law students in my attempt to warn them about drifting from the practical into the theoretical when doing so is inappropriate. Would it make sense for a government, whether federal, state, or local, to consider enacting a tax on time travel? One’s reaction surely would be, “No!” but a recent development causes me to think it could happen.

According to this report, the City Council of Broadview Heights, Ohio, is considering a proposal to raise its hotel tax from 7 percent to 10 percent. The catch? There are no hotels in Broadview Heights. The last hotel in the city closed about six years ago. The city council president who made the suggestion to raise the rate noted, “Now is the time to do it, when we don’t have a hotel. At least they [referring to hotels] will know what they’re getting into.” Or perhaps there are no hotels in town to lobby against the increase, which would bring the rate to double or triple the rate charged in the several other cities and towns that have hotel taxes.

A thought that passed through my brain was the possibility that the goal of the tax increase is to deter hotels from operating in the city, considering that it would generate a tax two to three times those applicable in other towns. But that idea was evicted from my mind as I continued to read the report. The city council president added, “The higher tax would bring a better hotel than what we’ve had in the past.” Really? So on the one hand there are state and local governments that hand out tax breaks to lure businesses into staying in, or relocating to, the jurisdiction, and yet here, on the other hand, is a proposal that increasing taxes will attract business. Perhaps the idea is that a higher tax generates higher prices, which would encourage the building of a hotel that caters to more economically blessed patrons. Is it an attempt to keep out budget-conscious folks who struggle economically?

To the extent that certain types of taxation is seen as a tool to discourage particular activities and behaviors, such as tobacco and gambling taxes, will governments consider enacting taxes on time travel even though time travel does not (yet) exist in an attempt to discourage research into time travel? Imagine the threat that time travel poses to governments and politicians.

Friday, September 01, 2017

Federal Income Tax Statutes Supersede Treasury Regulations

From time to time, when teaching the basic federal income tax course, a student would approach and explain that he or she was confused because something in the assigned regulations was inconsistent with what was in the statute. The best example is the personal and dependency exemption deduction amount. Though changed from time to time when Congress amended the statute and when adjusted for inflation, the regulations continued to refer to a now outdated $600 amount. I explained to the student, and the class, that with a long list of regulations projects, editing an amount in a regulation was given low priority because it was something people could, and should, figure out for themselves.

Confusion over the relationship between Internal Revenue Code and Treasury Regulations apparently is not limited to students in basic federal income tax courses. It popped up in a recent Tax Court case, Mitsubishi Cement Corp. v. Comr., T.C. Memo 2017-160. The taxpayer produced finished cement. One of the ingredients in its product is calcium carbonate which the taxpayer mines at one of its locations. The taxpayer computed depletion with respect to the calcium carbonate by deducting 15 percent of gross income from mining. The IRS argued that the taxpayer was limited to 14 percent of gross income from mining. The taxpayer relied on Treasury Regulation section 1.613-2(a)(3), which provides that 15 percent is the applicable percentage depletion rate for “minerals listed in this subparagraph,” which includes calcium carbonates. The taxpayer argued that the regulation is “an agency pronouncement that should be deemed a concession or stipulation” by the IRS. The taxpayer also cited Rev. Rul. 66-24 as evidence that the IRS has “valid[ated]” the rate provided in regulations section 1.613-2(a)(3), although that ruling concerned the application of the regulation to refractory and fire clay, and not to calcium carbonates. The taxpayer also offered an argument based on the legislative nature of regulations adopted under section 611.

The court, however, pointed out that the taxpayer ignored “the timing of the regulations in relation to the change in the controlling statute.” The court explained that the language in the regulations was adopted in 1960, when the statute provided a percentage rate of 15 percent for calcium carbonates. The Tax Reform Act of 1969 amended the statute, lowering the percentage to 14 percent. Thus, the percentage in the statute superseded and made obsolete the percentage in the regulations. The court also reminded the taxpayer that an agency regulation cannot supersede the language in the statute.

This is another instance in which amendment of a regulation provision has been assigned a low priority. The pace at which Congress amends the Internal Revenue Code outstrips the pace at which the limited number of attorneys in Treasury and in the Chief Counsel’s Office can update or draft regulations. Changing the number “15” to “14” is something that, like the personal and dependency exemption deduction amount, people can, and should, figure out for themselves.

This is another example of why, when conducting tax research, a person must begin with an identification of the applicable Code provision. There are many ways of doing that identification. But once accomplished, the next step is to read that Code provision. Reading something else, whether a treatise, a commentary on the web, a pamphlet, or some other material, is dangerous because it might be outdated. In this manner, when next turning to an explicatory aid, the researcher should recognize inconsistencies between what is being examined and what was read in the Code provision, thus alerting the researcher to a possible conflict. That conflict must be resolved in favor of the Code provision.